Vertical Integration. In Cable Television AEI Studies in Telecommunications Deregulation J. Gregory Sidak and Paul W MacAvoy, series editors TOWARD COMPETITION IN LOCAL TELEPHONY William J. Baumol and J. Gregory Sidak TOWARD COMPETITION IN CABLE TELEVISION Leland L. Johnson REGULATING BROADCAST PROGRAMMING Thomas G. Krattenmaker and Lucas A. Powe, Jr. DESIGNING INCENTIVE REGULATION FOR THE TELECOMMUNICATIONS INDUSTRY David E. M. Sappington and Dennis L. Weisman THE FAILURE OF ANTITRUST AND REGULATION TO ESTABLISH COMPETITION IN LONG-DISTANCE TELEPHONE SERVICES Paul W MacAvoy UNIVERSAL SERVICE: COMPETITION, INTERCONNECTION, AND MONOPOLY IN THE MAKING OF THE AMERICAN TELEPHONE SYSTEM Milton L. Mueller, Jr. TELECOMMUNICATIONS COMPETITION: THE LAST TEN MILES Ingo Vogelsang and Bridger M. Mitchell VERTICAL INTEGRATION IN CABLE TELEVISION David Waterman andAndrewA. Weiss Vertical Integration. In Cable Television David Waterman Andrew A. Weiss The MIT Press Cambridge, Massachusetts London, England and The AEI Press Washington, D.C. 1997 Distributed to the Trade by National Book Network, 15200 NBN Way, Blue Ridge Summit, PA 17214. To order call toll free 1-800-462-6420 or 1-717-794-3800. For all other inquiries please contact the AEI Press, 1150 Seventeenth Street, N.W., Washington, D.C. 20036 or call 1-800-862-5801. Published by The MIT Press Cambridge, Massachusetts London, England and The AEI Press Washington, D.C. © 1997 by the Massachusetts Institute of Technology and the American Enterprise Institute for Public Policy Research. All rights reserved. No part ofthis publication may be used or reproduced in any manner whatsoever by any electronic or mechanical means (includ­ ing photocopying, recording, or information storage and retrieval) without permission in writing from the Massachusetts Institute of Technology and the American Enterprise Institute, except in the case of brief quotations embodied in news articles, critical articles, or reviews. The views expressed in the publications of the Massachusetts Institute of Technology or the American Enterprise Institute are those ofthe authors and do not necessar­ ily reflect the views of the staff, advisory panels, officers, or trustees of MIT or AEI. Library of Congress Cataloging-in-Publication Data Waterman, David Vertical integration in cable television / David Waterman, Andrew A. Weiss p. em. - (AEI studies in telecommunications deregulation) Includes bibliographical references and indexes. ISBN 0-262-23190-5 (cloth: alk. paper) 1. Cable television-Vertical integration-United States. 2. Competition-United States. I. Weiss, Andrew. II. Title. III. Series. HE8700.72.U6W38 1997 384.55'51-dc21 96-51422 CIP Printed in the United States ofAmerica To Sharon, Chloe, and Jason, and to Christina, Alan, and Fiona Contents Foreword ix Acknowledgments xi About the Authors xiii 1 Introduction 1 Topics to Be Examined 4 Organization, Key Findings, and Recommendations 6 2 Social Concerns and Policy Issues 10 Controversies about Vertical Integration 10 Policies toward Vertical Integration in Cable 12 Related Issues in Cable Television 14 Policies toward Vertical Integration by Competitors to Cable Television 16 Criteria/or Evaluating Social Costs and Benefits ofVertical Integration 17 3 Market Structure ofthe Cable Television Industry 21 1j;pes ofCable Programming 21 Ownership Structure 22 Conclusion 42 Appendix: Data Collection Methodology for Cable Programming Network Ownership 42 4 Efficiency Advantages ofVertical Ownership in Cable 45 Transactions Efficiencies 45 Capital and Creative Resources ofCable Operators 50 Signaling Commitment 52 Conclusion 54 vii viii Contents 5 Vertical Integration, Strategic Behavior, and the Supply of Cable Programming 55 The Potential Role ofVertical Integration in Anticompetitive Behavior 55 MSO Monopsony Power, Free Riding, and Vertical Integration 74 Other Strategic Advantages ofVertical Integration 76 Conclusion 77 Appendix: MSa Monopsony Power and Free Riding 78 6 Empirical Effects ofVertical Integration in Cable 87 Premium Networks 89 Basic and Hybrid Networks 94 The Number ofNetworks Carried 98 Summar.y oj'Results 101 Interpretations 101 Conclusion 108 Appendix: Data Collection and Modeling Methodolog)J 109 7 Vertical Integration and Alternative Multichannel Video Delivery Systems 128 Vertical Foreclosure Theory and the Role ofIntegration 129 The Empirical Record 132 Conclusion 140 8 Summary and Policy Conclusions 142 Restrictions against Disadvantaging Unaffiliated Program Suppliers 143 Nondiscriminatory Access to Programming 146 Vertical Disintegration 151 MSO Size Limits 152 Vertical Integration in Cable as an Antitrust Issue 157 Vertical Integration by Alternative MVPDs 159 9 Postscript: The Time Warner-Turner Broadcasting Merger 165 References 171 Case and Regulatory Proceeding Index 183 Name Index 187 Subject Index 191 Foreword DRAMATIC ADVANCES IN COMMUNICATIONS and information technologies have been imposing severe strains on a government regulatory apparatus devised in the pioneer days ofradio and are raising policy ques­ tions with large implications for American economic performance and so­ cial welfare. Before the passage of the Telecommunications Act of 1996, one was compelled to ask, Is federal and state telecommunications regula­ tion impeding competition and innovation, and has that indeed become its principal ifunstated function? Is regulation inhibiting the dissemination of ideas and information through electronic media? Does the licensing regime for the electromagnetic spectrum allocate that resource to less than its most productive uses? Now that the 1996 act is in place, is it likely to correct any ofthose ill effects? David Waterman and Andrew A. Weiss assess the effects of vertical integration in the cable television industry. The study is one of a series of research volumes addressing those questions commissioned by the Ameri­ can Enterprise Institute's Telecommunications Deregulation Project. The AEI project is intended to produce new empirical research on the entire range of telecommunications policy issues, with particular emphasis on identifying reforms to federal and state regulatory policies that will ad­ vance rather than inhibit innovation and consumer welfare. We hope this research will be useful to legislators and public officials at all levels of government and to the business executives and, most ofall, the consumers who must live with their policies. The volumes have been written and ed­ ited to be accessible to readers with no specialized knowledge ofcommunica­ tion technologies or economics; we hope they will find a place in courses on regulated industries and communications policy in economics and communications departments and in business, law, and public policy schools. Each volume in the Telecommunications Deregulation Project has been discussed and criticized in draft form at an AEI seminar involving federal and state regulators, jurists, business executives, professionals, and aca­ demic experts with a wide range of interests and viewpoints and has been ix x Vertical Integration in Cable Television reviewed and favorably reported by anonymous academic referees selected by the MIT Press. I wish to thank all ofthem for their contributions, noting, however, that the final exposition and conclusions are entirely the responsibility ofthe authors of each volume. I am particularly grateful to Paul W MacAvoy, Williams Brothers Pro­ fessor of Management Studies at the Yale School of Management, and J. Gregory Sidak, F. K. Weyerhaeuser Chair in Law and Economics at AEI, for conceiving and overseeing the project's research and seminars, and to Frank Urbanowski,Terry Vaughn, andVictoria Richardson ofthe MIT Press for their support and steady counsel in seeing the research to publication. CHRISTOPHER C. DEMUTH President, American Enterprise Institute for Public Policy Research Acknowledgments T HIS VOLUME HAS BENEFITED in its conception and progress from the contributions and comments ofmany. We especially thank Timo­ thy J. Brennan, Charles L. Jackson, Leland L. Johnson, Paul W MacAvoy, David J. Salant, Martin L. Stem, Lawrence J. White, anonymous referees, and participants at an American Enterprise Institute symposium, where we presented a preliminary draft ofthis study. We also thank Leigh Tripoli and Julie Bassett ofAEI and Victoria Richardson and Ann Sochi ofMIT Press for their professional contributions to the editorial and production process. We are especially indebted to J. Gregory Sidak for his support and his very detailed comments and editorial contributions. Any errors and shortcom­ ings nevertheless remain with us. Completion ofthe research we report in this book required efforts ex­ tending far beyond our own. Erik Deutsch, Joseph M. Hinshaw, Krishna ~ Jayakar, Guy Katz, and ZhaoxuYan provided able research assistance. Cable industry executives generously granted interviews to help us understand the industry's inner workings. Staff members of the Federal Communica­ tions Commission went out of their way to assist us in finding and inter­ preting documents. And we shall always be grateful for the extraordinary librarianship ofCarolyn M. Spicer ofthe University ofSouthern California and Francis G. Wilhoit ofIndiana University. Finally, we acknowledge A. C. Nielsen Co. for their generosity in pro­ viding the data used in our econometric analysis, and we thank Indiana University and the University of Southern California for financial and ad­ ministrative support. Access to a number of government agency studies